Accounting in Action: CM Corporation (CMC)

Chapter 3

Accounting in Action: CM Corporation (CMC)

In anticipation of growing demand for their products and services, Conner and Martin hired two new directors, Suzanne Lopez and Allison Knepp, giving them stock in the company as part of their hiring bonus. The founders, Conner and Martin, along with the two new directors, will be the management “team.”

Conner and Martin consider themselves "upper management" and the two new directors "middle management." Conner and Martin have little accounting or business training so they are relying on Lopez and Knepp, both of whom have MBAs, to provide the business background. With the additions to the management team, CMC changed the company name to CM 2.

Given the lack of any trained accountant on board, an accounting intern can be of great value to CM 2. To familiarize you with the company's operations, Conner and Martin have provided an unadjusted trial balance from the end of last year (2009) on an Excel spreadsheet. When you look at it, you find that the accounts are not in any particular order, which surprises you.

Instructions

(a) Download file 3a from the website Excel File. Prepare a trial balance in good form.

(b) From the website, access file 3b Excel File , which has the unadjusted trial balance with the accounts in proper order. This file also contains an accounting “system” comprised of a series of linked spreadsheets. The linkages enable the effects of all accounting entries (journal, adjusting, and closing) to flow through to spreadsheets for the income statement, balance sheet, and statement of cash flows. You notice that for the fiscal year ended December 31, 2009, someone has made all the journal entries but none of the adjusting or closing entries.

The following information is provided for adjustments prior to closing the books. Lopez and Knepp ask you to enter the adjustments into the spreadsheet, in the two columns to the right of the unadjusted trial balance. (CM 2 uses a perpetual inventory system.)

1. Wages earned by employees during December and to be paid in January are $33,875; associated payroll taxes on these wages are $2,710.

2. On July 1, a client paid CM 2 $205,720 in advance for a year of consulting services.

3. You discover that a product sale was made and recorded in December for $128,600; the product had not yet been shipped. The cost of the product was $68,742.

4. Bad debt expense has been calculated to be $17,508 but has not yet been recorded.

5. The Prepaid Expense account has a balance of $22,774. This balance includes $11,200 for a two-year insurance policy purchased on January 1, 2009.

6. Depreciation expense for the year is $82,620.

7. Interest expense accrued on its long-term liabilities is $7,765.

8. On December 15, CM 2 declared a dividend of $110,000, to be paid on January 15, 2010.

9. Income tax expense is $201,109.

(c) After making the adjusting entries in (b), make the appropriate closing entries on the spreadsheet provided.

(d) Prepare a memo to management explaining the importance of the adjusting entries made in part (b). As part of this discussion, explain how accrual accounting improves the usefulness of the company's financial statements.

Additional Activity: Extend your accounting knowledge

You know that CM 2 is going to the market with a stock offering at the end of 2010. You have heard that investors look at certain relationships (or ratios) on the financial statements to understand the financial health of a company in which they plan to invest. You decide to examine several of these ratios to get a feel for how this company is doing. You know the following:

(1) The relationship of current assets to current liabilities is important to assess the liquidity of the company and its ability to pay its current bills.

(2) The total debt to total assets relationship describes where the money came from to acquire the assets.

(3) The net income to sales relationship tells how much of each sales dollar ends up as profit.

Instructions

Calculate these three relationships for CM 2 for 2009 and the prior year, and write a short assessment of CM 2’s financial position and performance.